ECON 205 2nd Edition Lecture 9 Outline of Last Lecture I The business cycle revisited II Macroeconomic Equilibrium III Multiplier Model IV Change in investment V Monopolies Outline of Current Lecture I Capital and assets II Effect of interest rate and rate of return III Time and Risks IV Profit Current Lecture I Capital and assets Capital goods are tangible and intangible durable products that are used for further production such as machinery buildings and manufacturing equipment Capital can be both inputs and outputs Structures that are capital include factories and homes equipment machinery and automobiles Inventories another form of capital include cars in dealer lots and unsold products Lastly intangible capitals are software patents brands and the like Capital is bought and sold in capital market Rentals are payments for temporary usage of durable capital or land II Effects of interest rate and rate of return Financial assets are monetary claims They increase productivity of other factors and are things like student loans mortgages and savings into investment These create values ex nihilo driving the economy The interest rate is the rate of return on fixed interest and financial assets Return on investment is the price of borrowing or lending money The rate of return depends on the asset s maturity the risk involved the cost taxes and credit Present value is the value of assets at the current time ROI is the rate of return on investment Determines allocation of capital into alternative investments Rate of return on capital has not fallen due to technological innovation The demand for capital slopes downward due to law of diminishing returns for capital When interest rate rises bond and stock prices fall Asset prices move inversely with interest III Time and Risks Time has an effect on yield rate Long term securities have higher interest than short term ones The risk involved is the chance that the security bond or loan will default or the company involved will become insolvent or bankrupt United States Treasury bonds are backed by the full faith credit and taxing power of the United States federal government and strengthened by the government s long history of honoring payments IV Profit Revenues minus costs equal profits Profits are also defined as residuals left over from operating costs wages maintenance and other expenses Subtract market value of owner s wages rental values and owner s interest in capital Economic profit however is equal to revenues minus all costs including implicit costs or opportunity costs Finally profit is also defined as the reward for risk bearing
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